The Siren Song of Capital Controls

ITHACA, NEW YORK – Capital controls are back in vogue. Facing sharp currency appreciation and fearing asset-price booms fueled by hot money, countries such as Indonesia, Korea, and Taiwan have recently taken steps to limit inflows.

Nervous central bankers in many other emerging markets, including India, facing pressures from exporters hurt by rising exchange rates, are contemplating broader controls on capital inflows as well. Earlier this year, the International Monetary Fund came out in favor of capital controls.

So, does the new fascination with capital controls hold up to scrutiny?

Capital controls remain a bad idea – an idea that is far more seductive in theory than in practice. Moreover, there is good reason to see inflows into emerging markets as an opportunity to strengthen domestic capital markets, rather than primarily as a threat to financial stability.